How Bill Gates gamed IBM…and 4 other tips to negotiating the best contracts for your business

How Bill Gates gamed IBM…and 4 other tips to negotiating the best contracts for your business

Published 23 June 2014 13:03, Updated 24 June 2014 13:38

Program on Negotiation at Harvard Law School

Sophisticated negotiators understand that a successful deal often hinges on hammering down the right contract language. In fact, choosing the wording is a negotiation in itself, one with its own unique pitfalls.

Five guidelines can help you master this difficult task.

1. DEFINE THE DEAL BEFORE YOU SET THE PRICE.

Consider the college dropouts whom a corporation hired for low wages to provide operating-system software for a new line of home computers. The company used its clout to drive a hard bargain on price, but the young programmers shrewdly added a clause that would enable them to sell their software to other customers.

As you might have guessed, the company was IBM, and the dropouts were Bill Gates and his friends. Since then their start-up, Microsoft, has done pretty well.

It was contract language, not price, that determined which side got the better deal in this case. The nimbler party saw potential value that the larger entity overlooked.

Of course bargaining can get tough when both sides are envisioning pots of gold. Less-powerful negotiators thus face a delicate task, arguing for their desired language without overemphasizing its importance.

2. KNOW THE WORDS’ WORTH.

Haggling over dollars doesn’t leave much room for creativity, but it does have the advantage of clarity. If you’re the buyer and the seller is dropping his or her price, you’re moving in the right direction. If the numbers are going the other way, you’re not.

How do you measure success when you’re trading words, not numbers? The key is to remember that words are means to your goals, not ends.

Take the noncompete clauses that employers often seek in order to prevent top talent from fleeing to the competition. This can lead to hard bargaining, because most recruits don’t want to be handcuffed. Securing noncompete language isn’t worthwhile, however, if it’s unlikely to be enforced – and courts often don’t favor such provisions.

Instead of battling over language that’s difficult or costly to enforce, look for other ways to achieve the same goal. Whenever you negotiate, be sure to calculate the trade-off between tangible economic benefits and possible limits on your options, and ensure that compromises on one front are compensated for by gains on another.

3. BALANCE PRECISION AND FLEXIBILITY.

Through the years J/Boats, a successful sailboat designer and marketer, has done many millions of dollars of business with its manufacturer, TPI Composites. The companies’ agreement is summed up in a single-page contract.

Now consider the reams of fine print you’re handed when you replace your cell telephone. Why is one deal done virtually on a handshake while the other is weighed down with legalese?

The simplicity of the J/Boats-TPI contract was a practical necessity. When their partnership began, in the late 1970s, neither side knew whether the business would grow or how to specify the cost and price of boats not yet conceived. Adapting as the market and technology evolved was essential, as was building mutual trust and confidence. Any attempt to spell out details would have been futile.

At the other end of the spectrum, although consumers rarely study their cell-telephone contracts, these documents cover a specified set of issues, such as contract length, scope of service and repair costs. The provider dictates the language governing those issues, but consumers have some latitude to choose the sort of package they want.

Many transactions fall between these two extremes, requiring some specification of rights and responsibilities while leaving certain terms open-ended. Trying to cover all the bases takes time and can obscure understanding. Straightforward statements of principle may provide more guidance than reams of boilerplate.

4. AVOID DOOM AND GLOOM.

Lawyers frequently are blamed for the unintelligible fine print that pervades contracts, often with due cause. After all, they’re the ones who insist on warranties, indemnification clauses and liability limitations. Given that lawyers are responsible for protecting their clients from potential harm, however, some of this criticism is unfair.

When attorneys focus on who owes what to whom in every imaginable worst-case scenario, however, they cast a pall over even the most promising deals. The remedy for negotiators: Keep sight of the big picture. Once you’ve won, or lost, on broader issues of principle, it’s easy to fall into the trap of quibbling over moot details.

5. NEGOTIATE THE RELATIONSHIP.

Carefully chosen contract language fosters better deals and stronger relationships. Stating that goal is one thing, though, and achieving it is another. You know what you intended to say in your proposal, but your counterpart may not read it that way. Even if his or her redraft doesn’t seem sinister on the surface, you might wonder what’s lurking between the lines. Your resulting defensiveness won’t help matters.

Consider that negotiation affects relationships in parallel ways. On a substantive plane, it defines future rights and responsibilities, which can raise fundamental issues of identity, fairness and respect. Equally important is the process used. When a long-term relationship is in the offing, the negotiation itself is a trial marriage. For better or worse, parties glimpse how well they’ll collaborate in the future and reflect that understanding in their formal agreement.

Sometimes the whole point of an agreement is to define a new relationship, such as the establishment of a business partnership. In such cases it’s important to face tough issues squarely, rather than to sweep matters under the rug. When you bargain too hard in the pursuit of self-interest, however, the relationship might be doomed from the start.

Ideally the process of negotiating terms and conditions should be one of mutual learning, one in which parties anticipate problems before resources are wasted or tempers flare. The best contracts are those that are signed, filed away and never looked at again.

Candor, patience and open-mindedness in the course of negotiation help foster healthy working relationships.

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About bambooinnovatorKB Kee is the Managing Editor of the Moat Report Asia (www.moatreport.com), a research service focused exclusively on highlighting undervalued wide-moat businesses in Asia; subscribers from North America, Europe, the Oceania and Asia include professional value investors with over $20 billion in asset under management in equities, some of the world’s biggest secretive global hedge fund giants, and savvy private individual investors who are lifelong learners in the art of value investing.
KB has been rooted in the principles of value investing for over a decade as an analyst in Asian capital markets. He was head of research and fund manager at a Singapore-based value investment firm. As a member of the investment committee, he helped the firm’s Asia-focused equity funds significantly outperform the benchmark index. He was previously the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. KB has trained CEOs, entrepreneurs, CFOs, management executives in business strategy, value investing, macroeconomic and industry trends, and detecting accounting frauds in Singapore, HK and China. KB was a faculty (accounting) at SMU teaching accounting courses. KB is currently the Chief Investment Officer at an ASX-listed investment holdings company since September 2015, helping to manage the listed Asian equities investments in the Hidden Champions Fund.
Disclaimer: This article is for discussion purposes only and does not constitute an offer, recommendation or solicitation to buy or sell any investments, securities, futures or options. All articles in the website reflect the personal opinions of the writer.

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